Fundamentals of how the stock market works
So you want to start learning about how the stock market works … but where do you start?
This is not to be an advanced guide for investing in financial markets. It is a necessary introduction for all those who want to learn and understand how securities markets work, in a straightforward and simplified way, without technicalities or complications. Therefore, if it is your case and you want to learn then go ahead.
The financial industry is really complicated. Today investors, brokers, dealers, lenders, borrowers, advisors, companies, banks, securities, stocks, funds, prices … and the list goes on and on. The financial world is vast.
That is why it is so important to have a global vision to understand how all these elements work together.
Stock markets are changing and evolving continuously. But at some point, we have to stop, let things go a little and take a look inside.
Why the financial industry exists
From time immemorial where barter dominated by metals like gold and silver to paper bills, and ultimately electronic invoices, money has always been present in our lives.
Money (in its different forms) appears from the need to exchange goods and services between individuals. People always have needs. We need food to eat, clothes to wear, etc. People are looking for ways to meet their demand.
Long ago, when people exchanged goods to get what they needed, they gave up other things they had. For example, meat was traded for milk. But not all products and services can be bought and sold. For example, you can not exchange wheat for electricity. This is where money is born as such.
Money is the intermediary
It handles the transaction between buyers and sellers.
But as our world has developed and has become more sophisticated money has become more important to meet the needs of people.
Companies are no longer shepherds who exchange sheep. Today we have multinational corporations that handle billions of dollars. To manage this evolution, the need arises to organize them. Therefore, this is where the financial industry appears.
In short, the financial sector has to do with the management of money: invest it, cultivate it, save it and, ultimately, spend it.
Stock markets are at the center of all this, where people (investors) and companies come together to conduct transactions and, respectively, manage their money.
The birth of stock markets as we know them today took place in 1602, with the Dutch company East India Company. Historians say it is the first company to offer shares to investors for a share of its profits.
Stock markets allow businesses to raise money without incurring or increasing their debt. They issue shares to the public through what is known as initial public offer or sale (IPO). Investors buy and sell these shares with each other in the stock market, so the quotes move up and down. If more people buy shares than the ones they sell, the price goes up because of the excess demand. If more people sell shares than those who buy, prices fall because nobody wants them at that price. Basically, this is how it works.
The stock market is beneficial for both parties, investors, and companies for two reasons:
- Companies raise money to grow their businesses.
- Investors invest money to grow their money.
Do you remember when you were a kid and in the schoolyard, you carried your cards to exchange them with your classmates? Well, stock exchanges work (simplifying) in a similar way.
A stock exchange is where investors trade their shares with each other. That is why stock prices are in continuous motion. If more people are selling more shares than those who buy, the price has to fall. If the opposite happens, the price will tend to rise. The role of the stock exchange is to homogenize and regulate all purchases and sales of securities.
Today there are many stock exchanges around the world. In the United States, the main stock exchanges are the New York Stock Exchange (NYSE), the Nasdaq (it is an index of the major technology companies) and the American Stock Exchange (AMEX). Like everything, technological evolution has allowed the stock exchanges to modernize, in this case, the internet has allowed the world of the financial industry to have grown incredibly to this day.
Today, most of the trades that are done are carried out over the internet, rather than being made on the physical parches of the bags. But that does not mean stock markets lose importance. Although everything is done online, each and every transaction goes through the bag to match buyers with sellers.
Types of Investors
In principle, we can distinguish two major types of investors: institutional and retail.
The institutional investors are large companies such as banks, investment companies, mutual funds or hedge funds that invest significant amounts of money on behalf of individual investors. They make up the bulk of the volume (number of shares traded) in the stock market. Because some of these companies are so large, their operations have a significant impact on the quotes or prices of a company’s stock.
The retail investors are those individual investors who put their money on the market alone, trying to grow your money, that is, someone like you or me.
Since the financial crisis of 2008, small investors have grown because they rely less on big banks and investment funds and choose to learn how the financial industry works. In this way, they control their own money and are financially independent.
Another reason why retail investment has increased is that the internet has meant a revolution in the financial world. The emergence of competitive online investment platforms has encouraged individual investors to invest in the markets. It is becoming easier to invest in real time and also at a lower price.
Brokers and stock companies
Buying an action is a bit more complicated than the purchase of a T-shirt. We could do the simile with the acquisition of a house. To buy a home, we will have to contact a real estate agent, who knows the housing market and works with people who want to sell theirs.
In this way, brokers or agents work. They are like real estate, but the stock market brokers buy and sell stocks on behalf of investors.
There are different types of agents. There are some that offer you a comprehensive service in which you will not only carry out operations for us but also manage our portfolio and give us investment advice. Others will simply do what we tell them, that is, we will have to tell them when to buy and when to sell, but also their price is lower.
The most important thing when it comes to choosing a right broker is the structure of the commissions they apply. Brokers charge investors in different ways, depending on the type of services we are looking for. They can charge us for a fixed amount, a percentage, a percentage of the profits, etc.
Lately one of the trends that are being imposed is social trading. That is to say, they are platforms of investment in which we will be able to see in what they invest other users and to copy their investments. That is, you can copy the best investors. Also they have numerous documentation that will allow you to learn to operate and you will be able to consult the rest of users doubts.
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